Creating an effective LLC operating agreement is not merely a bureaucratic step, it’s a protective measure, ensuring member interests, initial capital contributions, and management of liabilities, no matter if you are a single-member LLC or a multi-member one.
Drawing from our wealth of experience as financial advisors, we realized that oversight or miscalculation in this critical process can jeopardize ownership interests and even personal liability.
Hence, we bring you a guide to construct an articulate, tailored operating agreement for your limited liability company (LLC) to securely embark on this entrepreneurial journey, ensuring your LLC members are adequately protected and your business is set out on the right foot. Let’s dive in!
Brief Overview
- An LLC operating agreement, detailing ownership percentages and member’s duties, is highly recommended for clarity in financial and management procedures.
- It’s possible to draft your own LLC operating agreement, but understanding of specific state rules and legal language is necessary.
- If self-drafting seems complicated, consider alternatives like a business formation service or hiring an attorney, ensuring all business specifics are adequately addressed.
What Exactly is an Operating Agreement?
An operating agreement is a written agreement vital for an LLC’s organization. The written operating agreement outlines ownership percentages, distribution of profits, and member’s duties for a sole member or multiple people in a multi-member LLC.
This legal document can guide members on additional contributions, admittance of a new member, departure of an existing member, and provides a step-by-step approach to company decisions, dispute settlements, and managing LLC debt.
It also details major provisions like the LLC’s intended purpose, meeting requirements, and dissolution terms. Without one, an LLC follows the state’s default rules.
How Do You Write an Operating Agreement for an LLC?
An effective written operating agreement should detail the ownership structure, management roles, and financial arrangements within the LLC. It should also address potential disputes and dissolution procedures.
It’s important to write the LLC operating agreement in clear, concise language and have it reviewed by a legal expert.
Let’s take a closer look at the steps:
Step 1: Decide Ownership Distribution
The first step in crafting an LLC operating agreement involves deciding on the ownership distribution among the LLC members. This distribution is typically based on the capital contributions made by each member.
It’s essential to clarify each member’s ownership interest to avoid potential disputes in the future. According to this research study, assuming that the members’ shared interests are the same as their management, capital, and tax interests is a common mistake made in operating agreements that need to be corrected through a provision.
Step 2: Outline Rights, Tasks, and Reimbursement of LLC Members
The second step in drafting an LLC operating agreement is to explicitly outline the rights, tasks, and reimbursement of members.
This step includes defining the scope of LLC member duties, voting rights, expected additional capital contributions, and the process of reimbursing expenses towards the business.
Our hands-on exploration of LLC agreement practices suggests that clearly outlined member responsibilities can safeguard the smooth day-to-day operations of the business.
Step 3: Formulate Entry and Exit Guidelines for the LLC
In our experience, the agreement should provide concise guidelines on how new members are admitted to the LLC, their financial contributions, their roles and duties, and their voting rights.
For instance, it can stipulate that admission of new members requires a unanimous vote of existing members.
The agreement should also tackle the departure of a member, laying out any specific procedures or conditions. It may detail the process for buying out a departing member’s interest or how the member’s interest is to be divided among remaining members.
Step 4: Detail Terms for Dissolution and Severability
The agreement should define the steps for a possible dissolution of the LLC, such as settling disputes, distributing the company’s profits and remaining assets, and ceasing the business. It may state that dissolution requires a majority or unanimous consent of the LLC members.
The severability clause ensures that, if a provision is disallowed by state or federal law, only that provision is removed from the agreement while the remaining ones are enforceable.
This ensures the integrity of the entire agreement and protects the business structure and each member’s interests.
Prevalent Provisions in LLC Operating Agreements – A Check List
We typically include the following provisions when we draft an LLC operating agreement:
- LLC and Member Information: Stipulates the name of the limited liability company, its physical address, and the information of all the LLC owners, including their names, addresses, and contact details.
- Statement of Intent: This serves to reassure the state and anyone who interacts with your business that the LLC is legitimate and operating under the stipulated state laws.
- Business Purpose: Outlines the LLC’s intended activity or reason for existence. For example, if your LLC sells handmade jewelry, state it clearly.
- Duration: Some LLCs are designed to operate indefinitely, but if your LLC has a specific end date or event that will dissolve your LLC, that should be specified. For example, in a real estate LLC agreement, the completion of a project might mark the end of the LLC.
- Tax Treatment: While new LLCs default as a partnership (for multiple members) or a sole proprietorship (for a single member), your LLC might benefit more from electing to be taxed as a corporation. This section outlines how profits and losses will be allocated and how they will be reported for tax purposes.
- Management structure: Specifies if the LLC will be member-managed or manager-managed. Highlights the role of a business manager if there is one.
- Majority Consent: This outlines the percentage of member votes needed to approve certain actions.
- Member Meetings: Documents procedures for LLC owners to hold and conduct meetings.
- Registered Agent Information: The registered agent is a necessary provision for any LLC operating agreement.
- Company Debt: Provisions dealing with the management of LLC debt, ensuring personal assets are insulated from the company’s financial liabilities.
- Succession Plans: This provision in the LLC operating agreement outlines what happens in the event of the death or incapacity of a member.
- Dispute Resolution: Details procedures for resolving conflicts among members, potentially avoiding costly legal battles.
- Modification of the Agreement: Terms stipulating how the LLC Operating Agreement can be altered.
- Non-Compete Clauses: Member-managed LLCs may comprise a non-compete clause to prevent members from engaging in competitive practices.
Tip: During our financial counseling, we’ve noticed that a broad business purpose allows for more control and flexibility as the LLC grows and offers the possibility of branching out into new activities without the need to update the operating agreement.
Are Operating Agreements Legally Required?
Operating agreements, while not always legally required, are highly recommended. Few states in the U.S. mandate having one (California, New York, Missouri, Maine, Delaware), however, it’s considered a best practice for all LLCs, regardless of size.
The document provides clarity about financial and management procedures among members, preventing potential disputes. Without this agreement, default state rules apply that may not serve the best interests of your LLC.
For single-member LLCs, having an operating agreement helps establish separateness between the business and owner, aiding in maintaining limited liability status. It’s crucial to understand law varies by state, so always research your specific location’s requirements.
Types of Operating Agreements
Understanding how to categorically structure an operating agreement for your LLC is a critical step in your LLC business formation. There are different types of agreements to consider, each providing guidance for varying LLC structures.
1. Single-Member LLC Operating Agreement
A sole-proprietorship LLC operating agreement, as the name implies, involves only one member in the LLC formed.
This agreement outlines basic information about the LLC’s operations, and the owner’s obligations, and addresses how business decisions will be handled.
For example, if a single member wishes to amend the agreement, the document would outline a step-by-step guide on how to do so according to the state’s rules.
2. Multi-Member LLC Operating Agreement
Shifting to a multi-member LLC operating agreement, entails clarity on each individual member’s contributions and roles. This agreement is a legal document that addresses the ownership section and members’ rights.
For instance, it would provide specifics on the members’ percentage of ownership, departing member procedures, and how many votes each member has in relation to their share of the LLC’s profits.
3. Partnership Operating Agreement
Lastly, a partnership operating agreement serves as a contract among partners in situations where an LLC is jointly owned.
Our expert analysis indicates that this form of agreement is crucial in managing money matters, services rendered, and in settling disputes, as it is considered a legal document stipulating how profits will be distributed amongst the partners, how to add other members, and the responsibilities of each participating party.
Can You Write Your Own Operating Agreement?
Yes, you can certainly write your own operating agreement. However, it comes with its set of challenges. First, ensure that you are well-versed with your state’s specific rules and regulations. Second, the language used should be legally appropriate.
While DIY templates and guides are available online, the risk of missing important provisions or making misleading statements arises.
However, if you possess ample legal and business knowledge, creating your operating agreement provides flexibility and control over your business operations.
What Are Your Alternatives
If crafting an LLC operating agreement on your own seems daunting, there are alternatives. You may consider a business formation service, like ZenBusiness, which provides tailored operating agreement templates.
They assist in filling out your LLC operating agreement with essential details such as members’ contributions, ownership rights, and procedures for adding members or settling disputes.
Another alternative is soliciting the expertise of an attorney. They can create a comprehensive operating agreement that considers all unique business circumstances.
However, while they’re thorough with legal documents and ensure the inclusion of the necessary provisions like severability provision, they can be quite expensive.
In conclusion, while it’s possible to draft your own operating agreement, seeking professional assistance can save potential stress and legal complications down the road.
References:
- https://heinonline.org/HOL/LandingPage?handle=hein.journals/passtent11&div=9&id=&page=
- https://www.irs.gov/
